Sri Lanka banks on China

Sri Lanka has announced that it will be borrowing a $1 billion eight-year syndicated loan from China Development Bank. Chinese investments in Sri Lanka have raised concerns in recent years, particularly after Colombo was forced to hand over the Hambantota Port to China due to debt.

In 2017, Sri Lanka’s public debt was approximately 75% of GDP. In total, the country is expected to receive $6.35 billion in investments over the next 12 months. Sri Lanka’s current reserves are $9.1 billion.

Background

Bilateral relations between Sri Lanka and China are friendly. Historic and cultural ties between the nations date back centuries. In recent years, the two countries have strengthened ties. China has provided economic, military and technical assistance to Sri Lanka. China began investing large amounts of money in Sri Lanka after the 2009 civil war. This is largely due to Sri Lanka’s geographical location. The country plays a key role in China’s ambitious vision as dictated by the One Belt One Road project (OBOR). Nearly every South Asian country has signed onto OBOR. OBOR aims to increase the connectivity and cooperation among Asian countries, Africa, China, and Europe. This will provide a significant boost to China’s economy. Sri Lanka is one of the few countries that has supported China over the disputed South China Sea territory.

Hambantota Port was built by a Chinese company and funded by Chinese loans. However, Sri Lanka was unable to repay these loans due to poor performance and debt. As of May 2017, Sri Lanka’s total debt stood at $64 billion. As a result, Sri Lanka inked a $1.12 billion trade agreement with a state-run Chinese firm. The Sri Lanka Ports Authority sold a 70% stake in the Hambantota port to China Merchants Ports Holdings. The lease is for a period of 99 years. At the time, India voiced its concern that the port will be used by Chinese military. Sri Lanka has vouched that this will not happen. China has also revealed its plans for building an investment zone and a refinery in the region. The investment zone would be 6,000 hectares (15,000 acres). Read more on this project here.

China Development Bank

China Development Bank (CDB) was founded in 1994 as a financial institution under the control of China’s State Council. The CDB was incorporated in 2008 and later defined as a development finance institution in 2015. The company’s shareholders include China’s Ministry of Finance (36.54%), Central Huijin Investment Ltd. (34.68%), Buttonwood Investment Holding Co., Ltd. (27.19%), and the National Council for Social Security Fund (1.59%). The organisation claims to provide “medium- to long-term financing facilities that serve China’s major long-term economic and social development strategies.”

Analysis

Sri Lanka has now accepted a $1 billion syndicated loan from China Development Bank. The loan has an eight-year tenure at 5.4%. CDB was one among four bidders being considered for the loan. “All three others had three-year tenure and only China Development Bank had a bid for an eight-year tenure,” a top Sri Lankan finance official told Reuters. “It was a good offer. The loan has a three-year grace period. Then in the next five years, the government will be repaying $100 million biannually.”

Sri Lanka faces enormous debt. The current government has blamed the “colossal borrowing” by the previous administration for increased debt. Last month, Sri Lankan sovereign debt went up $2.5 billion due to increased debt servicing. Finance Minister Mangala Samaraweera has predicted that the crisis will only worsen in 2019, as the country is due to pay $4.3 billion next year. Samaraweera claims that 77% of next year’s repayments are from the previous administration’s tenure. The current administration is likely to borrow approximately $5 billion this year to refinance debts.

A number of experts have criticised Sri Lanka’s involvement in what one analyst called China’s “creditor imperialism.” Critics claim that Sri Lanka is sacrificing its sovereignty to China. Some reports have criticised BRI for its potential to create debt-sustainability problems, particularly in developing African and Asian nations. “Belt and Road provides something that countries desperately want – financing for infrastructure,” co-author of one such report, John Hurley, said. “But when it comes to this type of lending, there can be too much of a good thing.”

A recent analysis by Bloomberg News revealed that out of 68 nations that China has listed as part of the project, 27 have sovereign debt that has been rated as junk. The debt level of at least 8 countries that are part of the project may exponentially increase, according to projections. Earlier this week, the IMF warned that China-led infrastructure development projects are partly to blame for growing debt risk in Western Balkan Nations. Read more here.

Luxman Siriwardena, a former finance ministry official commented that Beijing’s investments bear certain similarities to the post-war Marshall Plan. “The Marshall Plan was brought in when the Americans wanted to resurrect or reconstruct Europe, but they didn’t do it for nothing -- they created a market for themselves, they developed allies,” Siriwardena said. “We have something like that now.”

Counterpoint

China has argued in favour of this initiative, noting that this could potentially revive and boost the economies of multiple countries across the world. It has responded to criticisms that OBOR lacks transparency by emphasising that there are “no back-room deals” when it comes to OBOR. “It is a transparent initiative that follows the golden rules of extensive consultation, joint contribution and shared benefits,” Foreign Minister Wang Yi said earlier this year.

Assessment

Our assessment is that OBOR and so called “economic diplomacy” has become a major feature of China’s foreign policy. As stated previously, we believe that the Belt and Road initiative will be a debt burden to countries who cannot repay the cost of loans, as was the case with Sri Lanka. Due to the country’s strategic location, China may be unlikely to relinquish its debt hold of Colombo any time soon. Additionally, we believe that projects such as the Hambantota port demonstrate the dangers of large scale infrastructure projects that do not take into account the actual developmental needs of a country.